Q2 2025
Kinsman Oak Investor Letter Q2 2025
July 30, 2025
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MARKET COMMENTARY
Liberation Day, and the catastrophe that ensued afterwards, is a mere a fever dream in the rearview mirror. Stock markets trampolined back to all-time highs like it never happened at all and the VIX meandered downwards to the right like a deflating balloon. After an action-packed start to the year, equity indexes remain relatively unchanged, and investors complacently shrug off a series of various warning flags.
As we write, tariffs once again take centre stage. President Trump announced a 90-day pause on April 9th which ignited the relief rally and trade “deals” announced since then kept pushing the market higher. But extensions and deals have not yet been negotiated with every country and companies are beginning to reassess what their sustained tariff exposure will be going forward. It’s difficult to pin down an exact number but the estimated effective tariff rate according to Bank of America Global Research is approximately 16% if further sector-specific tariffs emerge, an increase from an estimated 9.6% in May and 2.3% pre-election (Appendix A).
All Eyes on Rate Cuts
In conjunction with tariff policies, rate cuts have increasingly come into focus. The Federal Reserve finds itself under tremendous political pressure as President Trump relentlessly hammers Jerome Powell in the media for not cutting interest rates sooner and more aggressively. While some investors clamour for lowers rates too (although for much different reasons), FOMC members remain concerned about inflation and prefer a wait-and-see approach, especially given the uncertainty surrounding how tariffs will ultimately impact consumer prices.
Based on current financial conditions we do not believe rate cuts are necessary from a purely economic standpoint. Stocks are making fresh highs, the DXY is -12% since January, sentiment is overheated, houses remain prohibitively expensive for first-time homebuyers, and crypto has surged higher. None of these signposts are indicative of an economy in desperate need of easier monetary conditions.
However, politically speaking, the case for cutting interest rates is nuanced and conversation surrounding the national debt crisis is gaining steam. We will explore the situation in more thorough detail below but, at a high level, the government continues to spend recklessly, and interest expense has become the second largest line item only behind Social Security. Absent rate cuts, this problem will get exponentially worse over time.
Politicians believe the Federal Reserve can effortlessly facilitate incessant fiscal irresponsibility by simply cutting the cost of government debt back to zero and monetizing new issuance if necessary. In our view, not only is this view incredibly short-sighted but it’s also counterproductive. Artificially pinning short-term interest rates too low risks major yield curve steepening if long-term maturities skyrocket in response. The knock-on consequences would have profound implications for financial markets, valuation multiples, the real economy, housing prices, inflation, the currency, federal tax receipts, etc.
The most important thing is not when the Federal Reserve cuts interest rates or by how much. Rather, the most important thing is how the bond market will respond to those cuts and the subsequent, potentially destabilizing, chain of events thereafter. It’s impossible to forecast exactly how these unprecedented measures might unfold but the cascading fallout could possibly send the national debt crisis into hyperdrive.
GAUGING WHERE WE ARE NOW
The same themes that trounced the broader market over the past year were primarily responsible for the sharp rally since April lows. Mega-cap technology stocks, driven by continued AI enthusiasm, led the charge higher. Large caps outperformed small caps, and the Nasdaq Composite outperformed the Dow Jones Industrial Average, although the disparity between the indexes on a year-to-date basis isn’t really that drastic.
In our view, any broadening of leadership is mainly a function of the insatiable risk appetite that permeates every corner of this market. It would be an understatement to say that there has been a rapid resurgence in speculative behaviour for the lowest quality and most speculative risk assets across the board. The Levkovich Index is already back to euphoric territory and the S&P 500 valuation multiple is trading in its highest decile (Appendix B). Putting it all together, the current backdrop clearly suggests reckless investor sentiment combined with extremely stretched valuations which bodes poorly for prospective returns.
According to Bloomberg, Bitcoin-linked firms rallied 78%, quantum computing shares are up 69%, meme stocks advanced 44% and a basket of the most highly shorted securities rallied 29% during the second quarter. Some stock-specific examples include Coinbase (COIN), Robinhood, (HOOD), MicroStrategy (MSTR), Palantir (PLTR), and Circle (CRCL), all of which were up anywhere from 40% to 125%, and 90% on average. More broadly, the discrepancy between unprofitable technology versus mega-cap technology stocks is notable. Again, all of this is suggestive of overheated investor sentiment. Meanwhile, cryptocurrency is experiencing its own heyday.
Speculative fervor in cryptocurrency has been conventionally emblematic of reckless risk appetite. Fears of missing out are the proverbial lead foot pushing the pedal to the floor as investors heedlessly chase ever rising prices higher. We believe this notion is likely true for the time being as Bitcoin is strongly correlated to the Nasdaq and we have not yet seen compelling evidence to suggest a decoupling has taken place.
However, in our opinion, it is worth exploring the framework for what that may look like in the future should that day come. Under what conditions would sufficient groundwork be present for a decoupling event to take place? Bitcoin trades like a proxy for technology risk-on exposure but we wonder if it will ever become a proxy for the pending national debt crisis risk-off hedge. Recent developments such as the ineffectiveness of DOGE and passing of the One Big Beautiful Bill Act are unmistakable giant leaps forward in the era of fiscal dominance.
FISCAL DOMINANCE
We can’t help but notice the following as we contemplate the bigger economic picture:
Bitcoin is up +60% since its April low, reaching an all-time high of $120k.
Gold is up +41% over the past twelve months, reaching an all-time high of $3,500/oz.
The USD has had its worst start to the year and the DXY is down -12% since January.
M2 money supply reached a new all-time high in June, surpassing the previous peak in April 2022.
It has become abundantly clear that investors recognize and are concerned with the worsening (and, in our view, unfixable) national debt crisis. While any deeper meaning attached to the price action in Bitcoin can be dismissed by skeptics given how other speculative assets have performed since April, the same cannot be said about gold or the DXY. This is particularly true since a U.S. driven trade war and higher-for-longer interest rates should have both been bullish for the dollar and yet the DXY went straight down despite those tailwinds.
The United States government continues to accumulate unsustainable levels of debt as fiscal deficits remain out of control with no restraint in sight. The newly created Department of Government Efficiency (DOGE) was supposed to streamline spending, cut waste, and restore fiscal discipline. Like most government programs, it sounds great on paper but doesn’t really work as advertised. According to the DOGE website, estimated total savings are $199 billion (though it’s unclear how the word “savings” is defined or if those savings are recurring in nature). Regardless, those savings are dwarfed by the One Big Beautiful Bill Act which, according to the Congressional Budget Office, will add $3.4 trillion in debt over the next ten years.
The ability for a government to print its own currency can provide an illusion of solvency for a long time. Eventually, though, consequences from out-of-control structural deficits will surface in unexpected ways. Typically, rising inflation expectations cause long-term rates to gradually climb higher while equity valuation multiples collapse. Other, less obvious, distortions take place in financial markets and the real economy. We wonder if the price of cryptocurrency and/or Bitcoin will decouple from traditional risk assets, becoming one of those distortions.
It is worth revisiting how bad this inevitable crisis has become. At the time of writing, the U.S. national debt outstanding is approximately $37 trillion, and economists forecast another $1-2 trillion will be added by year end. For context, the national debt was $23 billion at the beginning of 2020, meaning a roughly $16 trillion increase (61%) over the past six years. The pandemic response was a drastic step-up in spending, but the government hasn’t exactly been prudent since temporary emergency measures rolled off. Since then, we have drifted so far away from any semblance of fiscal responsibility that balanced budgets have been reduced to figments of our imagination.
Net Interest Expense is now the second largest outlay by function, trailing only behind Social Security, and accounts for ~19% of total tax receipts (Appendix C). The prospect of rate cuts while every risk asset on the planet mints fresh highs is wildly irresponsible until you consider the genuine political concern of not doing so. Hawkish monetary policy drives interest expense higher and further limits fiscal options for policy makers who are utterly incapable of running a balanced budget. Obviously, when your administration is running such massive deficits, pressuring the Fed to lower short-term interest rates is really about solvency rather than massaging business cycles.
To reiterate, we believe rates cuts at the front end would cause the back end to rip higher. This dynamic played out the last time Powell lowered rates, and we expect the same thing to happen again, except even more so. But if all you care about is minimizing government interest expense to fund massive deficits, and you issue new debt only at the front end, you don’t really care how steep the curve gets. However, any sustained inflationary pressures associated with this scenario would instantly make this politically unpalatable, and the predictable implementation of yield curve control will make it even worse. Welcome to the world of financial repression.
Under these conditions we could envision a world where Bitcoin and maybe other cryptocurrencies serve as a true offramp from the upcoming fiscal insanity rather than the high-beta asset classes they behave like now.
FUNDAMENTAL HEADWINDS & WHERE WE SEE OPPORTUNITY
Fundamental headwinds persist in the midst of ongoing policy uncertainty, especially for small-to-medium sized businesses. The initial Liberation Day tariffs, ambiguous and confusing trade deals since then, numerous pauses and extensions while negotiations remained underway, various geopolitical conflicts, lower corporate and consumer confidence, and inflation worries just to name a few. Consumers are also stretched pretty thin given credit card debt is reaching new highs and young adults are financing burritos through buy now, pay later platforms (Appendix D).
The direction of the economy will be largely determined by the inflation trajectory (when and by how much the Fed cuts rates) and how companies respond to the finalized tariff policies (how much of that increase will be passed onto the end customer versus margin degradation). As we write, numerous businesses have cut forward guidance or removed it altogether for the sake of prudence. Commentary on earnings calls is cautious and, while the effects have not fully worked their way through the financials, management teams are no longer able to reliably anticipate what future results will look like.
While it’s easy to recommend investing in stocks which carry minimal tariff impact and avoiding stocks with heavy exposure, the reality is that’s likely already priced in, and that kind of first-level thinking is seldom rewarded. We continue to look for businesses with pending company-specific inflection points and overly pessimistic investor sentiment. We are reluctant to use the term turnaround because that typically suggests a low-quality business led by a below average management team, and those situations often turn into what we call “perpetual turnarounds”.
We also believe businesses with strong underlying business momentum or hidden growth segments can be interesting long positions. Investors can vastly underestimate the tail exposure for certain secular growth stories. Businesses with high ROIC hidden segments can result in a meaningful multiple rerating. Finding winners will always drive returns but we believe avoiding the losers becomes just as important during eras of disruption.
Artificial intelligence will render certain businesses totally obsolete unless they adapt and pivot directions. Without naming specific stocks, many subsectors are ripe for major change. Image generation tools will disrupt traditional photography companies. Drafting legal documents can be done through AI instead of human beings. Even blue-collar jobs are vulnerable to disruption with detailed DIY tutorials available on demand. Specialty research companies may no longer have a monopoly on medical or pharmaceutical information. We hesitate to say it but online dating platforms will face real competition from AI generated companions.
LOOKING AHEAD
Our concerns about the upcoming debt crisis predate the launch of the Fund and, so far, the economy still seems to be humming along despite some distortions within it. While the fiscal response to the pandemic was supposed to be a step function higher followed by a return to baseline, enough time has passed to conclude that will not be the case. Instead, the trajectory appears to have permanently changed course (Appendix E). But maybe enormous government spending can continue indefinitely without consequence for longer than we originally thought possible. Either way, this issue will be pushed further to the forefront of public discourse as time passes.
With respect to equities, we ultimately believe that the unbridled fiscal spending will outweigh any fundamental headwinds over the six to twelve months. However, every sentiment gauge is flashing red, and valuations are stretched so we wouldn’t be surprised to see a correction or pullback prior to year-end. Stagflation remains a real risk as manufacturers raise prices to partially offset rising input costs while absorbing the remainder internally. Sustained inflationary pressures will delay rate cuts until the Fed feels like they have it under control.
Performance has been dominated by a small handful of stocks over the past couple years, and we expect this phenomenon to reverse eventually. Financial markets, the economy, and the political landscape are all simultaneously experiencing a confluence of unprecedented characteristics desperately in search of a relief valve. This backdrop adds an element of unpredictability which, while risky, can be a source of tremendous opportunity.
Sincerely,
APPENDIX
Appendix A
BofA Global Research – Global Economic Viewpoint – July 22, 2025
Bank of America Global Research – The Flow Show – July 24, 2025
Appendix B
Citi Research – PULSE Monitor – July 11, 2025
Citi Research – PULSE Monitor – July 11, 2025
Appendix C
U.S. Department of the Treasury – Monthly Treasury Statement
Appendix D
Federal Reserve Bank of St. Louis – Consumer Loans: Credit Cards and Other Revolving Plans, All Commercial Banks
Appendix E
Federal Reserve Bank of St. Louis – Federal Debt: Public Total